The ‘top down’ approach to the recovery of insured and uninsured losses

The UK Court of Appeal recently considered the situation where an insured’s total loss exceeds the limit of indemnity, insurers have paid up to the limit of indemnity under the policy and where recoveries are made from a third party. The courts have confirmed that the correct approach is the ‘top down’ approach, where the recoveries are applied to the uninsured losses first.

Background

The respondents (Textainer) held a container lessee default insurance policy, which comprised a US$5 million retention, a primary policy of US$5 million and five excess layers providing cover up to $US80 million in excess of the retention. The applicants to the appeal comprised most of the insurers for the primary excess layer and the first to third excess layers (the insurers).1

In August 2016, one of Textainer’s lessees (Hanjin) applied for receivership, entitling Textainer to claim under the policy for the loss of containers, uncollected rent and the costs of retrieving and repairing recovered containers hired by Hanjin. Hanjin was declared bankrupt in February 2017.

The total amount paid to Textainer under the policy was US$75 million, leaving uninsured losses of around US$21 million. In May 2019, Textainer made a claim against Hanjin. Hanjin agreed to pay US$25.9 million to Textainer, and over a period of time, Hanjin’s Bankruptcy Trustee paid Textainer around US$14.7 million.

The proceedings

The insurers claimed to be entitled to 39.3% of the sums recovered by Textainer pursuant to the settlement (in circumstances where they indemnified 39.3% of Textainer’s total loss). Textainer maintained that it was entitled to retain all recoveries up to a total of US$56.4 million, being the total loss, less the US$40 million covered by insurers, and its US$5 million retention.

The insurers’ claim was dismissed by the High Court at first instance in October 2022. The court held that:

1. As a matter of principle, any recoveries were to be applied on a top down basis, and not a proportionate basis;

2. The insurers failed to prove as a matter of fact that the recoveries had been indemnified proportionately or at all by the primary policy and first three excess layers; and

3. This was not a case of statutory under-insurance,2 so recoveries were not to be shared pro-rata.

The insurers were granted leave to appeal the High Court decision, challenging each finding set out above. Textainer opposed the appeal.

The appeal

It is common ground that the doctrine of subrogation allows an insurer to ‘take advantage of any means available to the insured to extinguish or diminish the loss for which the insurer has indemnified the insured.’3 Therefore, ‘any recoveries received by the insured will inure to the benefit of the insurer with a view to diminishing the loss which the insurer has paid and indemnified.4 In this instance, the recoveries from Hanjin reduced Textainer’s total losses, but those losses still remained well above the upper limit of cover. The court determined that on the face of it, those recoveries did not engage the insurers’ right to be subrogated to recoveries made in respect of the insured losses.

The insurers attempted to distinguish the decisions of Lord Napier and Ettrick v Hunter5 and Kuwait Airways Corporation v Kuwait Insurance Co S.A.K6 in circumstances where those decisions applied to ‘stop loss’ policies, where the policies applied to a single financial loss that occurred on a single date. The insurers argued that Textainer’s policies covered the physical loss or damage to individual containers and the related costs as and when those losses were incurred, eroding the retention and then the excess layers one by one.

They contended that Textainer’s recoveries should not be regarded as a reduction in the total loss, but should be applied to the specific losses, where it was possible to do so – they also argued that it should be inferred the losses were suffered evenly and regularly over time, and as a result, the recoveries should be applied proportionately across the excess layers, so that 39.3% was payable to them.

The judge at first instance noted that the effect of the insurers’ primary case was that insurers on higher layers would not get the benefit of the reduction in the insured’s aggregate loss effected by recoveries to the lower layers, and that the effective limit of aggregate cover to the insured would be reduced.

The judge also considered that the insurers’ suggested approach would produce a different result depending on whether recoveries were made before or after payment by the insurers, noting that the position both before and after payment of a claim should be the same, and the limit of cover should not ‘depend on the happenstance’ of when any particular recovery is made.

It was also noted that the insurers’ argument would risk Textainer not receiving a full indemnity under the policies.

The court of appeal concluded that the nature of cover being provided by the policies was against particular layers of loss, and the manner in which the losses were determined and aggregated was not an important factor. If recoveries were not applied ‘top down’:

1. Textainer would not be fully indemnified for the amounts for which it was covered under the policies; and

2. Textainer would be in a worse position than if the recoveries had been made before the policies had been paid.

The court of appeal considered that the insurers’ arguments were based on a theoretical approach to the allocation of individual losses and determined that a broader approach is required to conform with the underlying principle of subrogation, which is that recoveries should be applied top down. The insurers’ appeal was therefore dismissed.

Conclusion

This decision serves as a useful reminder of the principles of subrogation, and how they are practically applied when the total loss exceeds the limit of indemnity. It is now well established that the ‘top down’ principle applies, and insurers will not be entitled to claim any recoveries obtained by the insured unless and until any aspect of the insured’s loss above the limited of indemnity is recovered.

In Australia, this principle is also applied by section 67 of the Insurance Contracts Act 1984, which provides that if an amount is recovered by an insured where an insurer has the right to subrogation, the insured is entitled to the amount recovered so long as it does not exceed the difference between the insured’s overall loss and associated costs, and the amount paid by the insurer in respect of the loss.

1 The rights of subrogation under the fourth and fifth excess layers were transferred to Textainer pursuant to negotiated settlement agreements, and they were therefore not a party to the proceedings.
2 within section 81 of the Marine Insurance Act 1906.
3 MacGillivray on Insurance Law 15th ed. 2022 para 22-001.
4 Ibid paras 22-005, 22-067.
5 [1993] AC 713.
6 [2000] 1 Lloyd’s Rep 252.

This article may provide CPD/CLE/CIP points through your relevant industry organisation.

The material contained in this publication is in the nature of general comment only, and neither purports nor is intended to be advice on any particular matter. No reader should act on the basis of any matter contained in this publication without considering, and if necessary, taking appropriate professional advice upon their own particular circumstances.

Mark Brookes
Partner
Greg Stirling
Partner
Hannah Hewitt
Solicitor

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